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REPORT ON EXAMINATION OF THE ADIRONDACK INSURANCE EXCHANGE AS OF DECEMBER 31, 2008 DATE OF REPORT JANUARY 29, 2010 EXAMINER FE ROSALES, CFE TABLE OF CONTENTS ITEM NO. PAGE NO. 1. Scope of examination 2 2. Description of Exchange 3 A. Management 3 B. Territory and plan of operation 5 C. Reinsurance 6 D. Holding company system 8 E. Significant operating ratios 10 F. Accounts and records 10 3. Financial statements 12 A. Balance sheet 12 B. Underwriting and investment exhibit 14 4. Losses and loss adjustment expenses 15 5. Compliance with prior report on examination 15 6. Summary of comments and recommendations 16 STATE OF NEW YORK INSURANCE DEPARTMENT 25 BEAVER STREET NEW YORK, NEW YORK 10004 January 29, 2010 Honorable James J. Wrynn Superintendent of Insurance Albany, New York 12257 Sir: Pursuant to the requirements of the New York Insurance Law, and in compliance with the instructions contained in Appointment Number 30361 dated June 24, 2009, and attached hereto, I have made an examination into the condition and affairs of Adirondack Insurance Exchange as of December 31, 2008, and submit the following report thereon. Wherever the designation “the Exchange” appears herein without qualification, it should be understood to indicate Adirondack Insurance Exchange. Wherever the term “Department” appears herein without qualification, it should be understood to mean the New York Insurance Department. The examination was conducted at the Exchange’s attorney-in-fact’s office at One Beacon Lane, Canton, MA 02021. 2 1. SCOPE OF EXAMINATION The Department has performed a single-state examination of Adirondack Insurance Exchange. This is the first financial examination of the Exchange after the report on organization, which was conducted as of May 17, 2006. This examination covered the period from May 18, 2006 through December 31, 2008. Transactions occurring subsequent to this period were reviewed where deemed appropriate by the examiner. This examination was conducted in accordance with the National Association of Insurance Commissioners (“NAIC”) Financial Condition Examiners Handbook (“Handbook”), which requires that we plan and perform the examination to evaluate the financial condition and identify prospective risks of the Exchange by obtaining information about the Exchange including corporate governance, identifying and assessing inherent risks within the Exchange and evaluating system controls and procedures used to mitigate those risks. An examination also includes assessing the principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation, management’s compliance with Statutory Accounting Principles and annual statement instructions when applicable to domestic state regulations. All accounts and activities of the Exchange were considered in accordance with the risk- focused examination process. The examiners also relied upon audit work performed by the Exchange’s independent public accountants when appropriate. This examination report includes a summary of significant findings for the following items as called for in the Handbook: Significant subsequent events Exchange history Corporate records Management and control Fidelity bonds and other insurance Pensions, stock ownership and insurance plans Territory and plan of operation Growth of Exchange Loss experience Reinsurance Accounts and records Statutory deposits Financial statements Summary of recommendations 3 This report on examination is confined to financial statements and comments on those matters that involve departures from laws, regulations or rules, or that are deemed to require explanation or description. 2. DESCRIPTION OF EXCHANGE Adirondack Insurance Exchange was incorporated under the laws of the State of New York on May 25, 2006. It became licensed on May 25, 2006 and commenced business on the same date. The Exchange was organized by White Mountains Insurance Group, Ltd., Bermuda (“White Mountains”) with an initial surplus to policyholders of $70,700,000. The initial surplus was provided by Homeland Insurance Company of New York, a subsidiary of White Mountains, pursuant to a loan agreement conforming to Section 1307 of the New York Insurance Law, which provides that such loan may only be repaid out of free and divisible surplus of such insurer with the approval of the superintendent. A. Management Pursuant to the Exchange’s declaration of initial subscriber and by-laws, management of the Exchange is vested in the advisory committee consisting of not less than nine members nor more than twelve members. The advisory committee meets annually during each calendar year. At December 31, 2008, the advisory committee was comprised of the following nine members: Name and Residence Principal Business Affiliation J. Paul Amaden, Sr. President and Chief Executive Officer, East Hampton, NY Amaden Gay Agencies, Inc. Louis Atti Vice President, Angola, NY ENB Insurance Agency, Inc. David R. Bauer President, Albany, NY Capital Bauer Insurance Agency Inc. Elizabeth M. Gardner Operations Manager, South Hampton, NY Maran Corporate Risk Associates, Inc. Thomas Scott McDaniel President and Chief Executive Officer, Williamsville, NY Adirondack AIF, LLC 4 Name and Residence Principal Business Affiliation John Scherrer President, Williamsville, NY The Northwoods Corporation, Potter, Harris & Scherrer Agency, Inc. John Vincent Stype President, Aquebogue, NY Neefus Stype Agency, Inc. Joseph Tedesco Vice President, Harrison, NY DeRosa, Rockefeller, Sohigian, Werdal Agency Michael Kelly Zimmerman Vice President, Claims Williamsville, NY OneBeacon Insurance Company A review of the minutes of the advisory committee’s meetings held during the examination period indicated that the two annual meetings were generally well attended and each advisory committee member had an acceptable record of attendance. However, the review of the minutes of the advisory committee revealed that the investment transactions for the years 2007 and 2008 were not formally voted upon and approved by the advisory committee during its annual meeting. It is important to note that materials which include the investment schedules (acquisitions & disposals report) were presented during the meeting; however, the minutes did not reflect that such materials were approved. Therefore, it appears that the Exchange did not fully comply with the Section 1411(a) of New York Insurance Law which states in part that: No domestic insurer shall make any loan or investment ... unless authorized or approved by its board of directors or a committee thereof responsible for supervising or making such investment or loan . . . It is therefore recommended that the advisory committee formally vote and approve the Exchange’s investment transactions at every meeting and that the minutes indicate such approvals to ensure full compliance with Section 1411(a) of New York Insurance Law. As of December 31, 2008, the principal officers of Adirondack AIF, LLC, the Attorney-in- Fact for the Exchange, were as follows: 5 Name Title Thomas S. McDaniel President and Chief Executive Officer Dennis Robert Smith Secretary Todd Colin Mills Treasurer Alexander Constantine Archimedes Vice President Bradford Whitman Rich Vice President and General Counsel B. Territory and Plan of Operation As of December 31, 2008, the Exchange was licensed to write business in New York only. As of the examination date, the Exchange was authorized to transact the kinds of insurance as defined in the following numbered paragraphs of Section 1113(a) of the New York Insurance Law: Paragraph Line of Business 4 Fire 5 Miscellaneous property 6 Water damage 7 Burglary and theft 8 Glass 11 Animal 12 Collision 13 Personal injury liability 14 Property damage liability 17 Credit 19 Motor vehicle and aircraft physical damage 20 Marine and inland marine 21 Marine protection and indemnity 22 Residual value 26 Gap Based on the lines of business for which the Exchange is licensed and pursuant to the requirements of Articles 13 and 41 of the New York Insurance Law, the Exchange is required to maintain a minimum surplus to policyholders in the amount of $9,900,000. 6 The following schedule shows the direct premiums written by the Exchange both in total and in New York for the period under examination: Premiums Written in New York State as a Calendar Year New York State Total Premiums Percentage of Total Premium 2006 $ 54,566,034 $ 54,566,034 100.00% 2007 $189,933,712 $189,933,712 100.00% 2008 $181,375,721 $181,388,084 99.99% The Exchange’s primary focus is providing personal lines property and casualty insurance coverages including but not limited to: automobile, homeowners, personal umbrella and dwelling fire in New York. The Exchange sells these personal lines property and casualty insurance products through a network of independent agents targeting markets in the state of New York. C. Reinsurance The Exchange did not assume reinsurance business for the period under examination. Ceded Reinsurance Program The Exchange has structured its ceded reinsurance program to limit its maximum exposure on any one risk as follows: Property The Exchange’s ceded reinsurance program for its property business is to limit its maximum exposure in any one risk to $1 million. The Exchange maintains an excess of loss coverage for standard losses which consists of one layer. Reinsurers’ single loss limit of liability is $5 million and the total cumulative policy limit is $20 million during any one contract year. The Exchange also maintains excess of loss coverage for property loss resulting from catastrophe event consisting of the following four layers. 7 Type of Treaty Cession Property Catastrophe excess of loss – $290,000,000 excess of $10,000,000 per Four layers as follows: occurrence 1st Layer – 54% authorized $10,000,000 excess of $10,000,000 2nd Layer – 39% authorized $30,000,000 excess of $20,000,000 3rd Layer – 58% authorized $80,000,000 excess of $50,000,000 4th Layer – 56% authorized $170,000,000 excess of $130,000,000 Casualty The Exchange has structured its ceded reinsurance program for its casualty lines of business to limit its maximum exposure in any one risk to $1 million. The Exchange maintains an excess of loss coverage for standard losses which consists of one layer. Reinsurers’ single loss limit of liability is $5 million and the total cumulative policy limit is $15 million. Personal Line Automobile Quota Share The Exchange also maintains an 8% quota share program for its personal lines automobile business with the following maximum limits: Automobile bodily injury liability: $500,000 each person, $1 million each occurrence Automobile property damage liability: $500,000 each occurrence Automobile bodily injury and property damage liability (combined single limit): $1 million each occurrence Automobile medical payments: $50,000 each person Automobile property damage: $500,000 each vehicle Personal injury protection: $100,000 each person However, in the event that the limits outlined above are exceeded, the reinsurer’s liability will not exceed its quota share portion of $6,250,000 for all coverages, all policies, any one occurrence. During the period covered by this examination, majority of the Exchange’s ceded reinsurance treaties were with authorized reinsurers. 8 It is the Exchange's policy to obtain the appropriate collateral for its cessions to unauthorized reinsurers. The examiner did not review these letters of credit for compliance with Department Regulation No. 133 since the amounts held under these letters of credit were not material. All significant ceded reinsurance agreements in effect as of the examination date were reviewed and found to contain the required clauses, including an insolvency clause meeting the requirements of Section 1308 of the New York Insurance Law. Examination review of the Schedule F data reported by the Exchange in its filed annual statement was found to accurately reflect its reinsurance transactions. Additionally, management has represented that all material ceded reinsurance agreements transfer both underwriting and timing risk as set forth in NAIC Accounting and Procedures Manual, Statements of Statutory Accounting Principles (“SSAP”) No. 62. Representations were supported by appropriate risk transfer analyses and an attestation from the Exchange's chief executive officer pursuant to the NAIC Annual Statement Instructions. Additionally, examination review indicated that the Exchange was not a party to any finite reinsurance agreements. All ceded reinsurance agreements were accounted for utilizing reinsurance accounting as set forth in SSAP No. 62. D. Holding Company System The Exchange is controlled by Adirondack AIF, LLC (“AAIF”), its Attorney-in-Fact. AAIF is a wholly-owned subsidiary of OneBeacon Insurance Group, LLC, which is ultimately controlled by White Mountains Insurance Group, Ltd. of Bermuda. A review of the holding company registration statements filed with this Department indicated that such filings were complete and were filed in a timely manner pursuant to Article 15 of the New York Insurance Law and Department Regulation 52. The following is an abridged chart of the holding company system at December 31, 2008: 9 White Mountains Insurance Group, Ltd. (Bermuda) OneBeacon Insurance Group, LLC (Delaware) Adirondack AIF, LLC (New York) Adirondack Insurance Exchange (New York) At December 31, 2008, the Exchange was party to the following agreements with other members of its holding company system: 1. Insurance Management Service Agreement with Adirondack AIF, LLC. The Exchange was a party to an insurance management agreement with Adirondack AIF, LLC pursuant to which, AAIF agreed to provide all necessary services for the operation of the Exchange including the right to perform solicitation, underwriting, classification of risk, rating of and premium determination for insurance contracts, adjusting of claims, collection of monies due to the Exchange; issuing, modifying and terminating insurance contracts, and the authority to determine appropriate premiums rates. The management fee is 14% of gross written premiums. It is noted that this agreement was non-objected to by the Department. 2. Investment Management Agreement with White Mountains Advisors, LLC The Exchange was also a party to an investment management agreement with White Mountains Advisors, LLC ("WMA") pursuant to which, WMA provides investment research and advice, including the execution of orders for the purchase and sale of securities. The agreement states that WMA will act as a discretionary advisor with respect to the assets of the Exchange and supervise the investments as described in the investment guidelines. WMA agrees to provide the Exchange with reports containing the status of the investment account at least monthly, and will 10 provide written advisory report letters to the Exchange on a quarterly basis. It is noted that this agreement was non-objected by the Department. E. Significant Operating Ratios The following ratios have been computed as of December 31, 2008, based upon the results of this examination: Net premiums written to surplus as regards policyholders 239% Liabilities to liquid assets (cash and invested assets less investments in affiliates) 75% Premiums in course of collection to surplus as regards policyholders 23% All of the above ratios fall within the benchmark ranges set forth in the Insurance Regulatory Information System of the National Association of Insurance Commissioners. The underwriting ratios presented below are on an earned/incurred basis and encompass the two-year and seven-month period covered by this examination: Amounts Ratios Losses and loss adjustment expenses incurred $182,683,400 60.87% Other underwriting expenses incurred 140,228,751 46.73 Net underwriting loss (22,804,111) (7.60) Premiums earned $300,108,040 100.00% F. Accounts and Records A review of the Exchange’s accounts, records and annual statement reporting revealed the following: 1. Annual Statement Preparation During this examination, the following errors in reporting certain items in the filed 2008 Annual Statement have been identified: i. In Schedule E – Part 1 – Cash, the Exchange incorrectly identified the bank holding its cash deposit of $6,144,098 as Bank of America. The correct bank should have been Bank of New York Mellon. 11 It is recommended that the Exchange exhibit greater care in the preparation of its filed annual statement. 2. Uncollected Premiums Over 90 days Past Due A review of the filed annual statements as of December 31, 2006, 2007 and 2008 revealed that the Exchange reported “zero” amount under non-admitted assets – (over 90 days past due for the uncollected premiums and agents’ balances in the course of collection - annual statement line 13.1). However, based upon the review of the information provided by the Exchange for uncollected premiums and agents’ balance in course of collection, it was noted that uncollected premiums over 90 days past due amounted to $174,233. Section 1301(a)(6) of the New York Insurance Law states in part: In determining the financial condition of a domestic insurer … there may be allowed as an admitted assets of such insurer … Premiums in course of collection … not more than ninety days past due … Based on the above-noted information, the Exchange did not comply with the above- referenced section of the law because it included uncollected premiums over 90 days past due as admitted assets in its 2008 filed annual statement. It is recommended that the Exchange comply with Section 1301(a)(6) and going forward report all uncollected premiums over ninety days past due as non-admitted assets in future annual statement filed with the Department. 12 3. FINANCIAL STATEMENTS A Balance Sheet The following shows the assets, liabilities and surplus as regards policyholders as of December 31, 2008 as determined by this examination and as reported by the Exchange: Assets Assets Not Net Admitted Assets Admitted Assets Bonds $160,012,569 $ 0 $160,012,569 Cash, cash equivalents and short-term investments 32,969,774 0 32,969,774 Investment income due and accrued 1,562,903 0 1,562,903 Uncollected premiums and agents' balances in the course of collection 15,349,606 0 15,349,606 Deferred premiums, agents' balances and installments booked but deferred and not yet due 22,495,605 0 22,495,605 Amounts recoverable from reinsurers 944,148 0 944,148 Net deferred tax asset 1,504,309 0 1,504,309 Sundry balances 1,645,533 107,547 1,537,986 Total assets $236,484,447 $107,547 $236,376,900 13 Liabilities, Surplus and Other Funds Surplus Increase Liabilities Examination Exchange (Decrease) Losses and Loss adjustment expenses $ 66,038,199 $ 64,102,199 $(1,936,000) Commissions payable, contingent commissions and other similar charges 9,061,889 9,061,889 0 Other expenses (excluding taxes, licenses and fees) 2,107,309 2,107,309 0 Taxes, licenses and fees (excluding federal and foreign income taxes) (1,112,395) (1,112,395) 0 Unearned premiums 80,154,082 80,154,082 0 Advance premium 1,908,277 1,908,277 0 Ceded reinsurance premiums payable (net of ceding commissions) 1,228,447 1,228,447 0 Amounts withheld or retained by company for account of others 549 549 0 Drafts outstanding 3,139,286 3,139,286 0 Payable to parent, subsidiaries and affiliates 3,164,317 3,164,317 0 Aggregate write-ins for liabilities 4,853,658 4,853,658 0 Total liabilities $170,543,618 $168,607,618 $(1,936,000) Surplus and Other Funds Surplus notes $ 70,700,000 $ 70,700,000 $ 0 Unassigned funds (surplus) (4,866,718) (2,930,718) (1,936,000) Surplus as regards policyholders $ 65,833,282 $ 67,769,282 $ (1,936,000) Total liabilities, surplus and other funds $236,376,900 $236,376,900 NOTE: The Internal Revenue Service has never audited of the Exchange’s Federal Income Tax returns. 14 B. Underwriting and Investment Exhibit Surplus as regards policyholders decreased $4,866,718 during the two-year and seven-month period examination period May 18, 2006 through December 31, 2008, detailed as follows: Underwriting Income Premiums earned $300,108,040 Deductions: Losses incurred $ 53,649,011 Loss adjustment expenses incurred 29,034,389 Other underwriting expenses incurred 140,228,751 Total underwriting deductions 322,912,151 Net underwriting gain or (loss) $ (22,804,111) Investment Income Net investment income earned $16,603,107 Net realized capital gain (548,427) Net investment gain or (loss) 16,054,680 Other Income Net gain or (loss) from agents' or premium balances charged off $ (217) Finance and service charges not included in premiums 186,323 Aggregate write-ins for miscellaneous income 405,249 Total other income 591,355 Net income before dividends to policyholders and before federal and foreign income taxes $ (6,158,076) Dividends to policyholders 0 Net income after dividends to policyholders but before federal and foreign income taxes $ (6,158,076) Federal and foreign income taxes incurred (28,943) Net income $ (6,129,133) 15 Surplus as regards policyholders per report on examination as of May 17, 2006 $70,700,000 Gains in Losses in Surplus Surplus Net income $ 0 $6,129,133 Net unrealized capital gains or (losses) 0 88,080 Change in net deferred income tax 1,458,042 Change in nonadmitted assets 0 107,547 Total gains and losses $1,458,042 $6,324,760 Net increase (decrease) in surplus (4,866,718) Surplus as regards policyholders per report on examination as of December 31, 2008 $65,833,282 NOTE: This is the first examination of the Exchange. 4. LOSSES AND LOSS ADJUSTMENT EXPENSES The examination liability for the captioned items of $66,038,199 is $1,936,000 more than the $64,102,199 reported by the Exchange in its December 31, 2008, filed annual statement. The examination analysis of the loss and loss adjustment expense reserves was conducted in accordance with generally accepted actuarial principles and was based on statistical information contained in the Exchange’s internal records and in its filed annual statements. It is noted that the Exchange has recognized approximately $970,000 of the estimated deficiency in its 2009 annual statement. 5. COMPLIANCE WITH PRIOR REPORT ON EXAMINATION There is no prior report on examination as this is the first examination of the Exchange. 16 6. SUMMARY OF COMMENTS AND RECOMMENDATIONS ITEM PAGE NO. A. Management It is recommended that the Advisory Committee formally vote and 4 approve the Exchange’s investment transactions at every meeting and that the minutes indicate such approvals to ensure full compliance with Section 1411(a) of New York Insurance Law. B. Accounts and records i. It is recommended that the Exchange exhibit greater care in the 11 preparation of its filed annual statement. ii. It is recommended that the Exchange comply with Section 1301(a)(6) 11 and going forward report all uncollected premiums over ninety days past due as non-admitted assets in future annual statement filed with the Department. Respectfully submitted, /s/ Fe Rosales, CFE Associate Insurance Examiner STATE OF NEW YORK ) )ss: COUNTY OF NEW YORK ) FE ROSALES, being duly sworn, deposes and says that the foregoing report, subscribed by her, is true to the best of her knowledge and belief. /s/ Fe Rosales Subscribed and sworn to before me this day of , 2010.
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